Whoever you are, wherever you are and whatever you do, you are being bombarded by many powerful signals.
Some awareness of the signals around us will help us realise the future we want to secure instead of being rendered speechless victims of economic forces we never saw coming.
I decided to write a book that will help a person with no background in economics to better understand the world economy.
We will begin with an alternative explanation of wealth creation and the source of GDP.
Worldwide, we are witnessing the breakdown and renegotiation of the social contract that exists between citizens and their states. This has already generated historic events, from the Arab Spring to the return of a “Cold War” environment between the US and other superpowers.
The word “economics” conjures images of complex mathematical equations and dry concepts such as “marginal additional demand”. It is not surprising that we sometimes shy away from thinking about such things.
Economics is not actually about numbers. Economics is about human behaviour too.
“In evaluating people you look for three qualities: integrity, intelligence and energy. And if you don’t have the first the other two will kill you.”
Still, there are always those who long to “check out” of the world economy. This instinct underpins all those who rail against globalisation and the market economy.
Standing still is not an option because defending yesterday – that is, not innovating – is far * more risky than making tomorrow. Someone else is always innovating, even if we are not.
The only constant in life is change, which is why the riskiest thing is often doing nothing or being unaware.
“Control your destiny or someone else will!”
As in the 1930s, today there is an inclination to believe, to hope, that someone in the corridors of power in the nation’s capital can fix the problem. Most of us can cope with a stock market that goes up and down, even one that moves violently.
What most of us cannot tolerate is a world in which our faith and belief in the market mechanism is broken.
Those who would normally oppose the expansion of the state become quiescent, conceding that only the state has the power to address economic problems.
Indeed, when casually observing the world economy today, we find that the state has emerged as the most important participant in the market. It is a profoundly serious signal that central banks have become the most important price makers in the market.
This raises an important question for modern democracies. Do we want a world where the state controls the distribution of wealth, power and prices, or where the market is in control? This is not just an economic question. It is a political question.
But, in the end, managing the risks in the markets cannot be devolved to some third party, like the state, who can make the future safe. Risk and opportunity are our own responsibility. This is an uncomfortable thought and a lot of people won’t like it.
The Queen asked, “Why didn’t anybody see it coming?” in 2007. The answer is, they did. The most popular topic of discussion that year was the imminent disaster in the credit markets. Most of my clients spent hours hypothesising about how the inevitable would play out and indeed how to profit from the coming debacle.
If mathematical genius comes not from solving equations but from knowing which equations to solve, then policy genius comes not from manipulation of the data but from knowing which data it is useful to manipulate.
It means that the conversation about the condition of the world economy involves people with varying agendas throwing a lot of math – often skewed math that is opaque and inaccessible – at a confused public, while ignoring the things that cannot be easily quantified.
So, to be clear: there is a need to understand the motivations of those who are sending the most important signals in the world economy – policymakers.
The divide that faces the world is no longer between the left and the right or between the followers of those two titans of economics, JM Keynes and Milton Friedman.
The divide is between the state and the citizen and between those who favour strengthening of the one versus the other.
The algorithm for a politician is simple: you must win to have power. They need policies that are popular and potent in order to win. Usually this means responding to events rather than pursuing an agenda of their own choice.
It’s not very likely that a policymaker who opposes bank bailouts will end up employed by Citigroup. It is very likely that a policymaker who forcefully pursued the bank bailout will be rewarded with a significant contract, even if not visible to the public, and possibly a serious role.
The media also calculate. Their algorithm is clear: cash flow is driven by stories, especially stories that sell. In order to get stories that sell they need to have sources. In the political arena, there are only two kinds of people in politics as far as the media are concerned: sources and targets. Failure to divulge stories makes you a target. In general, targets get bad press and sources get good press.
Policymakers and politicians know that they have the power to deny access to the media. So, those who write stories that policymakers don’t like find that they cannot get a meeting.
When you think about it, the purpose of the news is not to educate the public. The purpose is to generate revenue and income.
This is why all print media increasingly use algorithms to write the news stories themselves.
Some three minutes after an earthquake occurred in California on the 17th of March 2014, the first article the Los Angeles Times published on the story was generated by a robot.
The financial crisis of 2007/8 threatened to bankrupt the entire global banking system. The problem was not that one large bank was bust, but that virtually every large bank was bust simultaneously.
This led to the historic experiment in which major central banks have resorted to unconventional measures such as Quantitative Easing to push interest rates down and asset prices up.
The Federal Reserve and many other central banks in large economies are doing whatever is necessary to create inflation.
All the staff deny that they have profoundly altered the balance of power between the state and the market. All will vehemently deny that central bank independence has been jeopardised, even though central banks are now the largest buyers of the sovereign debt of their own nations. They will also deny that their actions will create inflation or that there is any risk of inflation that cannot be controlled, when history suggests that playing with fire results in… Fire.
Taxation is inevitable. It pays for the things that serve the collective interest. Over-taxation can call people to arms, however. The line between the two, between taxation and over-taxation, is embedded in what we can call a social contract between citizens and the state.
Democracies and modern forms of government tend to promise that you will be given something valuable in exchange for your tax payment.
But, when governments ask for too much of the citizen’s hard earned cash, and don’t deliver on their promises, protests arise. There are always signals that such events are unfolding.
The current state of the world economy is causing social contracts around the world to break.
Naturally, protests have begun. Protests are a signal.
It would be nice to believe that the social contract is sound, but there are signals everywhere that it has broken.
They are simple signals like the announcement that the US Postal Service might only deliver mail only five days a week, or that the British National Health System may start charging for certain procedures.
The social contract is not necessarily written, but it is understood.
The social contract seems strong when there is enough growth, cash and wealth creation opportunities to meet everyone’s needs. Prosperity glosses over the growing imbalances between promises and the means of fulfilling such promises.
The burden of debt is now testing many assumptions about how we have chosen to distribute wealth and the power.
It pits those who believe capitalism failed against those who believe the state failed to regulate capitalism properly.
It also pits states against each other as they seek to control cash flows and assets that would remove the pressure from their own citizens.
We may not like a particular social contract, but the very fabric of society is always based on some sort of deal between citizens and their state.
And, there are always moments in history when governments go broke and default on their promises to their citizens, thus putting the social contract under severe distress, if not destroying it altogether.
The debt problem in the industrialised world is sufficiently large that it is unravelling the social contract.
The magnitude of the debt is so huge that the human brain cannot process it purely mathematically.
It is sobering when we realise that the US, the UK and many other indebted nations would still be left with a decade-long debt repayment problem, or more, even if the government taxed every citizen 100% of their income.
Keep in mind that interest rates in the US, and most of the West, are at the lowest levels recorded since the Roman Empire (or nearly so). The chances that they stay at this historic low level for the next decade are not good. So, the cost of the debt is probably going to rise at some point, potentially worsening the problem exponentially.
In short, it is politically impossible and mathematically difficult to pay the debt now owed by the industrialised nations.
Someone has to pay for the loss. The social contract has to break. The only question is who will bear the loss and the pain? This depends on how the debt will be defaulted upon and therefore how the social contract will be broken.
It is hard for people to understand the debt problem because many don’t realise they have borrowed any money.
Therefore, it is hard to be surprised that people are surprised by the magnitude of the debt problem.
What’s done is done, except that many do not understand what was done: the losses were moved from the banking system to the government’s already over-indebted balance sheet, thus pushing the losses onto us, the public.
The price is that we saved the banking system at the expense of the social contract.
The state simply cannot absolve the financial sector of all its substantial losses and remain solvent itself. Something has to give. The state has to break and renegotiate the social contract to survive.
Here are the five principal ways in which governments typically default on their creditors.
Argentine/Russian-style default.We can wake up one day to hear a government simply announce, “We are never going to pay you back. Ever.” This is called an Argentine-style default because that is exactly how Argentina defaulted in 2001.
Haircuts A government can say, “We are definitely going to pay you back but a little bit later or a little bit less or both.” This sounds a lot nicer.
Austerity A state can default on the promises it made to its citizens. This is called austerity.
Devaluation The government can also allow or force the value of the currency to fall against other currencies so that our nation’s goods and services become cheaper, letting us earn more from sales abroad.
Inflation Inflation is the most invisible and immediately painless option (the pain comes later). All the government has to do is “print” more currency and/or more bonds, and reduce interest rates to practically nothing so that the cost of money – the interest rate – is free, at least “free” to the banks.
Injustice is done when interest rates are artificially suppressed because it assists the borrowers at the expense of the lenders, who are the savers. It shifts the balance of power in a society because inflation is a form of taxation, if not expropriation and confiscation.
It is a means by which the state steals money from the savers and the weaker members of society in order to serve its own interests and those with vested interests.
If anything captures the zeitgeist of the world economy today it is this sense that we are now in a lottery; we are gambling and the only known factor is that the “house” – the government – decides the outcome.
As the public begins to understand the starkness of the outcomes, populists gain greater sway.
There are those in Brussels and European capitals who believe that the old social contract may have evolved around democracy, but the new social contract in Europe may have to be imposed on the people. After all, according to these elites, the public doesn’t know that this is in their best interest.
The social contract is also being renegotiated in Britain. The government has chosen to rely on lower interest rates, devaluation of the currency, and austerity as the principal means of restoring growth.
It is fairly obvious when the British authorities announce that the National Health Service will no longer provide certain types of surgeries without applying a personal surcharge, meaning the citizen must now contribute to the cost.
So, even though the British may be angry about the breakdown of the social contract they thought they had, many foreigners are finding that the new British social contract beats the one they have at home.
All over the world, as the social contract breaks or changes, the public begins to ask that simple question. “Why is the state making decisions about how to distribute wealth and power in my society in ways that don’t benefit me?” This pits the government against the citizens and the citizens against each other, which is something that will affect everyone.
Does Quantitative Easing result in a qualitative squeezing of the poor? And, if the effort to reflate and inflate succeeds, have we just set the stage for another fifty or a hundred years of government intervention?
Is it possible that the same price pressures that are giving rise to social unrest in the emerging markets might also be eroding the income and health of the poor even in the industrialised world?
The loss of faith and hope in the future is going to provoke arguments and fights.
It is going to generate conflicts. It is in these ways that the world economy transforms the peace dividend into a conflict premium.
China and Russia and every other nation is now propelled into a fight for assets by economic forces. When there isn’t enough cash to go around and the value of these assets is rising every day, it is not surprising to see nations pursue control over commodities and assets with ever more vigor.
Inflation has begun to creep back into the world economy, undermining the efforts of emerging markets to deliver the aspirations of their people.
It would be somewhat foolish to even attempt to deny that the industrialised world is seeking to raise the inflation rate when every possible step has been taken to secure this outcome.
The only questions are whether it will work and whether it will create unwanted or unmanageable consequences at home or abroad.
The vice of economic pressure is tightening its grip on every person, every company, every community, and every country. Caught between loss of growth and loss of faith in the future on one side, and the rising cost of living, which means a falling standard of living, on the other. People are in pain.
The pain of the debt burden and the pain of a rising cost of living are bearing down in varying proportions in different parts of the world.
All seems grim but all these pressures produce the one thing that is required for the economy to sustainably grow: innovation.
Citizens ask questions about the social contract that’s in place with their government and seeks to modify it or reinvent it. The process of innovation is the positive outcome of pain.
Innovation is the one truly effective and desirable way out of the formidable pressures that are bearing down on the world economy and on social contracts today.
Arguing about the redistribution of wealth is a mug’s game in which all sides adopt intractable, ideological positions.
Innovation, on the other hand, creates wealth, enhances productivity and facilitates the transition from past limitations to future opportunities in tomorrow’s economy.
What matters is that now we are all being forced by extraordinary economic pressures to ask the question we should ask ourselves every three years: “If we were not already doing this, would we be doing it now?”
When you run out of money you have to think. You have to innovate.
Common sense tells us we must reinvent ourselves if we are going to find a job or sustain our earning power in a world where growth is low and unemployment is high. Indeed, if we live longer we may have to reinvent ourselves several times in a lifetime.
The only question is whether or not we choose to “be the change” or simply be residual consequence of change in our global economy.
The sharp demands of reality draw forth strength of character and cause some of us to explore and exploit change without the conviction and clarity of vision that others need before they are willing to act.
As I write in 2014, many in the market observe that transactions are occurring at higher prices on less collateral and easier lending terms than even before the crisis began. Some argue that the risk in the banking system today is even higher than it was in 2007.
It all comes back to the weakness of recent economies and the accumulation of debt incurred in trying to revive faltering economies. As states reach for revenue and default on their citizens in various ways, the pain level rises.
The rising level of pain compels governments to become far more innovative in their effort to secure cash from their citizens: taxation, expropriation, and inflation are some methods; defaulting on promises, reducing benefits and slashing payments are others. Every such decision has consequences for every member of our society.
But, in the main, governments are today, under the burden of debt, focussing more on taking wealth from its citizens than on investing in their future well being.
In one sense, QE is a sadomasochistic policy that involves giving free money to the financial services community and then punishing them for using it in any way other than the sort of old-fashioned lending that most banks are no longer designed for, not equipped for, and not willing or able to undertake.
Assuming we do not support Communism or Socialism as an economic model, profit is the lifeblood of the economic system. (If we do support these other systems, then we still need to figure out how to generate more income than the government is paying out or else face certain bankruptcy as a nation.) If the economy fails to generate profit, it will kill any business and any nation as well.
The decision to inflate is not a technical economic decision. It is also a political and social justice decision.
Is it real progress if the stock market goes up but the standard of living goes down? Is it real progress if holding down interest rates gives rise to an inflation, even a small one, that the rich can outrun but which traps the poor?
In the UK, another signal sends a shiver down the spine: customers have been shocked by jumps of 10% and above in the cost of energy bills, water bills and transportation, and were appalled when the Prime Minister’s spokesman suggested people should just cope with the cold weather by wearing “more jumpers”
Meanwhile, the signals from geopolitics are rattling the economic cage evermore loudly.
President Xi Jinping said in July 2014 that “Sino-US cooperation will achieve things that are beneficial to both countries and the world, while confrontation will be disastrous.” Clearly it is worth paying attention to the signals emanating from this issue. Meanwhile, President Putin warned the world he was going to challenge what he calls America’s “Universal Diktat”, by which he means the US Dollar-led world order. He feels America is now exporting “chaos” in multiple ways.
Of course, if one looks at the expansion of NATO eastward since the Fall of the Berlin Wall, one can understand why Russia’s leaders feel the West has been overaggressive and provocative.
Taken together, these many signals convey that we have re-entered a period of conflicting ideas and goals which may be resolved militarily.
Germany has deported the CIA station chief, ostensibly on spying charges.
Why is the US spying on Germany? One could say the US is spying on everybody.
The reality is that Germanys’ seeming alignment with Russia (perhaps driven by the dependence on energy) has caused the US to view Germany as an ally of Russia. This raises a profound geopolitical problem given that the whole purpose of the US military presence in Germany and across Europe is to defend Germany from Russia. Awkward. This is a geopolitical problem for the world.
Central banks are strongly signalling their desire to “do whatever it takes” to strive for “optimal control”236 in an effort to protect the poor, the weak and the innocent from the damage of debt and deflation.
QE is gradually becoming recognised as a mechanism for redistribution of wealth from the poor to the rich.
This takes place in a world where wages as a percentage of GDP stand at a record low and profits at a record high, thus foretelling sense of social injustice that will further undermine the social contract.
Unemployment in every economy remains uncomfortably high while wages remain at record lows as a percentage of GDP, even though profits have risen to record levels.
But, the real question is, whatever the cause, how much pain can the public bear before they choose to exit, thus undermining the power of both the state and the citizen to resolve the debt problem?
Social unrest is not going to be confined to emerging markets.
Unemployment remains too high, lending remains too low and the debt problem continues to grow.
Throughout the world, the social contract is coming under growing political pressure as the debt burden bears down on each and every citizen, company, community and country.
The question is what will you do?
One choice we have is to continue arguing about how to divide and redistribute the existing economy.
But the reality is that historic decisions have already been made that will define the economic landscape for years to come.
The lines between the power of the state and the power of the individual are being redrawn by economic circumstances. There is little use in complaining about the outcome if we fail to influence it.